Would a Goldman disclosure have helped?

By Felix Salmon
April 19, 2010
posted by Alphaville -- the 49-page September 10 memo, and the 20-page September 25 follow-up. But even without reading the whole thing, it's easy to dismiss the section excerpted by Henry Blodget, which claims that the kind of disclosure the SEC was looking for "would provide a potential investor with no information the investor did not

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I’m still working my way through the two Goldman Sachs responses to the SEC, as posted by Alphaville — the 49-page September 10 memo, and the 20-page September 25 follow-up. But even without reading the whole thing, it’s easy to dismiss the section excerpted by Henry Blodget, which claims that the kind of disclosure the SEC was looking for “would provide a potential investor with no information the investor did not already know”.

But that’s simply not true, as the first line of Goldman’s own slighly-sarcastic disclosure statement reveals:

The Portfolio Selection Agent has received recommendations as to the content of the Reference portfolio from third parties, including a third party that intends to take a short position with respect to the Reference Portfolio.

Upon reading that disclosure, the Portfolio Selection Agent (ACA) would immediately have learned something about which Fab Fabrice had assiduously kept them in the dark — that Paulson intended to go short the CDO.

At that point, the whole history of meetings with Paulson would start being replayed in ACA’s mind a bit like that shoe-dropping moment at the end of a David Mamet film, where the structure of the con is revealed. Only in this case, it wouldn’t have been too late, and ACA would have run very far and very fast in the opposite direction, vowing never to deal with Paulson, Tourre, or Goldman ever again.

It’s still far from clear whether the SEC can or will attempt to pin conspiracy-to-defraud charges on Paulson — my feeling is that they considered the idea, but dropped it for lack of hard evidence. But it’s very clear that this simple disclosure would have done a lot of good. If ACA knew full well that Paulson, with whom it had gone back and forth so many times putting together the portfolio, was in fact constructing it with the express intention of going short, then at that point no one’s lying any more, and there’s no real case to be answered.

So yes, the addition of that disclosure would have made all the difference. As Goldman well knew, because it carefully left that bit out of both the pitchbook and the formal prospectus. If such a disclosure would have added no new information, then there would have been no reason to leave it out.

5 comments

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felix: i think this one is more important:

http://dealbook.blogs.nytimes.com/2010/0 4/19/the-goldman-defense-caveat-emptor/

Goldman says:
“Similarly, the fact that ACA may have perceived Paulson to be an equity investor is of no moment. As a threshold matter, the interests of an equity investor would not necessarily be aligned with those of ACA or other noteholders, and holders of equity may also hold other long or short positions that offset or exceed their equity exposure. Indeed, Laura Schwartz of ACA understood this from her work on a transaction that closed in December 2006 in which Magnetar, a hedge fund that bought equity and took short positions in mezzanine-level debt, participated. (See GS MBS-E-007992234 (“Magnetar-like equity investor”).) Certainly, ACA could have questioned Paulson about its interests if it that information were significant to it.”

Posted by KidDynamite | Report as abusive

“At that point, the whole history of meetings with Paulson would start being replayed in ACA’s mind a bit like that shoe-dropping moment at the end of a David Mamet film, where the structure of the con is revealed. Only in this case, it wouldn’t have been too late, and ACA would have run very far and very fast in the opposite direction, vowing never to deal with Paulson, Tourre, or Goldman ever again.

ARE YOU OUT OF YOUR MIND? NOW YOU ARE PREDICTING COUNTERFACTUAL HISTORICALS. HOW MANY ABS and SYNTHETIC CDOs HAD ACA MANAGED TO THAT POINT?

Posted by TinyOne | Report as abusive

TinyOne –

Felix is right. If they had found out Paulson was short, it would have been game over, then and there. Paulson picked the debt he thought would fail? Dear God!

It is a much more ridiculous counterfactual to imagine ACA would have remained in the game.

In any case, the case is strong whether or not ACA would ultimately have gone long. Paulson’s role was highly material and in fact central to the deal no matter how ACA would have reacted to the news.

Posted by DanHess | Report as abusive

“It is a much more ridiculous counterfactual to imagine ACA would have remained in the game.”

Why do you believe this? In any arm’s length, zero-sum derivatives deal, it is normal for both buyers and sellers to have some hand in structuring the “product” to be traded, based on their mutually contradictory notions of value and/or risk preference.

Posted by AEinCH | Report as abusive

ACA were paid a fee as selection agent. It’s obvious now that the bonds which Paulson proposed were particularly stinky. But why does his motivation for doing that matter?
Suppose he really had wanted to go long but was particularly useless. Isn’t it the job of ACA to spot that the bonds he chose all seem to be on mortgages in California with no paperwork to back them up? If Paulson could do that based on publicly available information, why couldn’t ACA as an alleged expert.
ACA through a different branch was the biggest single investor. The complaint basically says that ACA (investor) was misled to believing that ACA (selector) had chosen the bonds.
This is laughable. Paulson found that there were a lot of stupid people on the market who were wrong about mortgages overall and who were not willing to do the study of the details which he did. That’s what used to be called “research.”
There are so many dreadful things which the investment banks did to cause the crisis. It’s pathetic that the SEC pick on this one, where a broker observed the principle of client confidentiality.
I understand that people hate Goldman because it has been enormously successful and only exists because the US taxpayer bailed it out. That’s no excuse for this suit.

Posted by Gobannian | Report as abusive